Implicit Contracts and the Theory of the Firm

NBER Working Paper No. 6177Issued in September 1997NBER Program(s): CFIO

We analyze the role of implicit contracts' (that is, informal agreements supported by" reputation rather than law) both within firms, for example in employment relationships between them, for example as hand-in-glove supplier relationships. We find that the optimal" organizational form is determined largely by what implicit contracts it facilitates. Among other" things, we also show that vertical integration is an efficient response to widely varying supply" prices. Finally, our model suggests why management' (that is, the development and" implementation of unwritten rules and codes of conduct) is essential in organizations. "